To make it simple, debt consolidation loans allow you to streamline multiple high-interest debt accounts into one installment loan with one payment. Getting a consolidation loan involves the following:
Be aware that debt consolidation loan may help you transfer multiple high-interest credit balances into one account, ideally with a lower annual percentage rate (APR).
Consolidating all the money you owe into one loan might appear to make life easier, but there might be better ways of dealing with your debts. Find out more about how debt consolidation loans work
Another thing is that You might be offered a secured loan if you owe a lot of money or if you have a poor credit history.
It’s important to get free debt advice before you consider taking out a secured debt consolidation loan. This is because they won’t be right for everyone and you could just be storing up trouble or putting off the inevitable.
What is a debt consolidation loan?
If you’ve got lots of different credit commitments and you’re struggling to keep up with repayments, you can merge them together into one loan to lower your monthly payments. And you borrow enough money to pay off all your current credit commitments and owe money to just one lender.
So now You may also consolidate your debt with a longer loan term to reduce your monthly payment, although doing so could result in owing more interest. You can apply for a debt consolidation loan by following these five steps.
1. Make Sure You valuate Your Financial Situation
So right before starting the process, take stock of your debt and weigh the pros and cons of debt consolidation to determine if a debt consolidation loan is a good option. Here are some reasons debt consolidation may make sense:
- First of alll Saves money: If you have a lot of high-interest debt, often from credit cards, a debt consolidation loan can reduce the total amount you pay over time. The average credit card interest rate is 18.43%, while the average rate for personal loans is 10.16%, according to the Federal Reserve. A debt consolidation loan could still work for you even if you have bad credit. Use a credit card payoff calculator to run the numbers and see if debt consolidation could save you money.
- Built-in repayment plan: With revolving credit like credit cards, you borrow and repay funds on an ongoing basis, with no end date in sight. By contrast, personal loans come with a repayment term, typically two to five years, which can make budgeting easier.
- Get out of debt faster: Choosing the shortest loan term you can comfortably afford allows you to accelerate your repayment schedule and get out of debt faster.
- Reduces your payment: Opting for a longer loan term may lower your payment, but be aware you’ll likely pay more in interest charges over time. Of course, using a personal loan to consolidate debt may not be a good option for the following reasons:
- May receive a higher interest rate: If your credit is below average, you may not qualify for a lower interest rate than what you currently pay. In that case, consider taking the time to improve your credit before applying for a personal loan.
- Could increase debt: Consolidation loans give you the opportunity to zero out your credit card debt by transferring it to a single installment loan. If you rack up charges on your newly freed-up credit cards, you could end up with more debt than when you started.
- Low debt balance may not be worth it: If you can pay off your existing debt in less than a year, the savings from a debt consolidation loan may be too minimal to be worthwhile.
2. Try to Check Your Credit
Next, get a copy of your credit reports and review them for accuracy. You should also understand your credit scores because debt consolidation lenders will review your credit reports and scores when deciding whether to approve you for a loan. (Familiarize yourself with credit scoring ranges and what is considered a good score.) Your scores will also help lenders determine your APR.
If your score is in the good or excellent range, you probably have a strong chance of getting approved for a personal loan with a low APR. But if your credit is in the fair to poor range, it may be a little trickier to consolidate your debts.
So however, there are loans geared toward people with less established credit or lower credit scores. Just keep in mind that applicants with lower credit scores often receive higher interest rates on their new debt, so it’s important to pay attention to the rates when you apply.
3. Be sure to Compare Debt Consolidation Loans
Taking the time to shop around and compare multiple loan offers can help ensure you get the lowest rate on a debt consolidation loan. Follow these tips to make sure you get the best loan possible while addressing other concerns:
Get the Best Terms Possible
Since a debt consolidation loan is supposed to save you money, it’s important to make sure your new interest rate is lower than your existing rates. Review all your borrowing options before picking a debt consolidation loan, as some may offer better terms and benefits than others. In addition to your own bank, check out other banks and credit unions, as well as Experian’s marketplace for a full selection of debt consolidation loans.
Look at the Lifetime Cost of the Loan
This calculation will help you understand how much money you can save in interest by using a debt consolidation loan.
Say you have $5,000 in credit card debt with an average APR of about 25%. Over 36 months, your monthly payment is approximately $199, and you will pay a total of $2,157 in interest.
So if you consolidated this debt into a new loan with an average APR of 17% over 36 months, the total amount you’d pay toward interest would drop to around $1,417, and your monthly payment would come down to $178. Over the life of this loan, you will have saved approximately $739 in interest.
Then Beware of Penalties and Other Fees
However, so many loan products come with origination fees or prepayment penalties that could be quite steep. For example, origination fees typically cost 1% to 8% of the borrowed amount. If you plan on paying off your consolidation loan early, make sure your loan doesn’t include a prepayment penalty, which could cost you up to 2% of your outstanding balance.